No Prepayment Penalty Loan: The 3 Best Options
Posted by Frank Gogol
Flexibility in your finances can be hugely important in providing some breathing room in times of financial difficulty, and this is especially true of personal loans. The more inflexible the terms, the more likely you will run into trouble repaying your loans.
A prepayment penalty is the exact kind of inflexible loan term that can cause you difficulty and penalizes you for getting out of debt quickly. This article discusses prepayment penalties and explores lenders that offer loans without these penalties.
Table of Contents
What are Prepayment Penalties?
Prepayment penalties are a fee that lenders levy against borrowers when the borrower repays their loan before the scheduled loan term.
Personal Loan Prepayment Penalties
For a personal loan, you will agree to a certain set loan term, over which you will repay the principal amount, plus interest.
So, let’s say you take out a $5,000 loan at 10% interest, and have a loan term of 2 years. You agree to 24 monthly payments of $230. Then, let’s say you have a cash windfall, or earn a bonus at work after one year, and decide to pay down the full amount at that point. This would save you hundreds of dollars in interest. However, if the lender charges prepayment penalties, these penalties could cut into this savings, or swallow it entirely.
Why Do Lenders Charge Prepayment Fees?
Lenders earn money by charging interest, and the longer the loan term, the more interest will accumulate. If you pay off your loans early, the lender is losing out on the interest payments for the remainder of the loan. Since the earnings from this interest are factored into the terms and interest rate that the lender initially offers, some lenders reserve the right to charge a fee if you pay off your loans early.
How Much Are Prepayment Penalties?
The cost of prepayment penalties varies greatly, depending on how the lender chooses to calculate the penalty, as well as the type of loan and the length of time left on the loan term. The three main ways that prepayment penalties are calculated are:
- Percentage of balance: Let’s say you try to pay off the full remaining balance on a 5-year loan term after 4 years. The lender may charge a certain percentage of the remaining balance that you pay off at that point as a prepayment penalty.
- Interest: Taking the same example of paying off a 5-year loan after 4 years, a lender may, instead, charge you 1 year worth of interest payments
- Flat fee: Other lenders, rather than tying the penalty to the amount of interest or balance left over, simply charge a flat fee for any borrower that pays off a loan early.
Do All Loans Come with Prepayment Penalties?
No, some lenders charge prepayment penalties and others do not.
Loans That Might Have Prepayment Penalties
You might have to incur prepayment penalties in varied kinds of loans, including:
Prepayment penalties are most commonly imposed by mortgage loans. Although these penalties have become less common after the 2008 housing crisis, there still exist various mortgage loans which impose an appreciable fee, which can amount to thousands of dollars.
In most cases, the prepayment penalty is not imposed when you put small amounts of money towards your loan principal. However, if you pay off a large amount at once, or finish the entire loan within a short span of time (say, a few years), your lender might impose a penalty on you.
The actual amount of penalty is dependent on the lender. This fees could be calculated based on the lump sum or the amount pending to be paid back. Not to forget, various states also place financial limits and additional time on these fees.
Although mortgage loans are commonly known for imposing penalties, you can encounter similar penalties on various other kinds of loans too. Auto loans, for instance, often come with a prepayment penalty section.
You can find a similar clause on personal loans as well. However, there are various personal loan lenders like Prosper, Discover, and Wells Fargo which advertise that they don’t impose any such fees.
3 Best Lenders for a No Prepayment Penalty Loan
If you want to maximize your financial flexibility and give yourself the option of paying off your loans early, you should seek out a lender that does not charge prepayment penalties. There are a number of prominent lenders who do not charge prepayment penalties, and we have listed some of the most well-regarded in the following section.
Stilt is an online lender, headquartered in San Francisco, California, that services the immigrant and noncitizen community in America. Immigrants often have difficulty obtaining loans because of the temporary nature of visa status and their lack of credit history. Stilt seeks to remedy this by establishing eligibility criteria that consider other factors besides credit.
Stilt’s loan services cater to immigrants and noncitizens in other ways as well. Immigrants can use as much financial flexibility as possible, so Stilt does not charge prepayment penalties. This can be especially valuable for immigrants whose visa status changes or who need to leave the country and pay off loans quickly.
At a glance:
- Interest rate: 7.99%-15.99%
- Max. Loan Term: 2 years
- Max. Loan Amount: $25,000
LendingClub offers personal loans with no prepayment penalties as well. Rather than functioning as a traditional lender, LendingClub is a peer-to-peer lender, which involves pairing borrowers with individual lenders who provide the funds for loans. LendingClub is the largest online lender for personal loans in the U.S. However, LendingClub also has fairly high standards, and loans primarily to borrowers with high income or a good credit score.
At a glance:
- Interest rates: 6.95% to 35.89%
- Max. loan amount: $40,000
- Max. term length: 5 years
SoFi is another of the most prominent online lenders that offer no prepayment penalty loans. SoFi offers larger amounts than Stilt and LendingClub, topping out at $100,000. However, their eligibility criteria are steep, with the average borrower with Sofi earning more than $100,000 per year. SoFi offers flexibility with their terms, however, including no late fees and hardship protections.
Interest rates: 6.99% to 15.49%
Max. loan amount: $100,000
Max. loan term: 7 years
Are Prepayment Penalties Always Legal?
If you hate prepayment penalties, you are not alone. In fact, prepayment penalties are considered to be a risky loan feature by the Consumer Financial Protection Bureau. Following this, the agency made strict rules in 2014 on how much a lender can charge in penalties.
It is important to mention here that strict rules have been imposed on prepayment penalties so much so that some states have completely banned these penalties irrespective of the type of the loan. However, not all banks are regulated by state law and some banks also operate under federal law. This is why it is highly recommended to check with your loan provider regarding their policies.
How to Avoid Prepayment Penalties?
If your lender has included any prepayment penalty clause in your loan, it will be there in your loan estimate and also in your closing documents. This is why you must read your loan documents properly to avoid any unforeseen events and surprise expenses. The clause about the penalty might be hidden in the section called the Addendum to the Note. Thus, read Addendum very thoroughly.
If your loan has any penalty of this kind, your contract must have it. Before signing on the dotted line, read everything about the penalty closely. Do not forget to negotiate the fee away.
Additionally, if your loan comes with a prepayment penalty, you should also ask for alternative options with no such penalties. This will help you in comparing your options better. However, if your lender doesn’t provide any such options, you can always change your mind and get better options from other lenders.
If the prepayment penalty seems to be inevitable, in such cases you must talk to your lender clearly and get your doubts cleared, if any. Here are a few questions that you must seek answers for:
- The prepayment penalty is applicable under which circumstances?
- Do I need to pay a penalty only on full payment or in partial payments too? If the prepayment penalty is applicable on partial payments too, how much can I pay off before the fee is levied?
- If mortgage loan offers prepayment penalty, is it applicable on refinanced or sold?
- How much is the exact fee and how is it calculated?
How to Deal with Prepayment Penalties on an Existing Loan?
If you already have a loan but are not sure if it includes a penalty clause or not, then it is the right time to check your closing documents, loan coupon book, account statements and other communication that you might have received from the lender. If you are still not sure, you should ask your lender.
In an event when you have already accepted a loan with a prepayment penalty, there is nothing much that could be done. However, you can put your best foot forward by knowing about the actions which will trigger this penalty, and doing your best to avoid them.
You can talk with your lender to discuss the involved mathematics. Then, do some calculations to find out what it will cost you if you get it refinanced or pay it off early. If this helps you in saving the money in the long run, you should go for it.
The quicker you get out of debt, the better, and yet prepayment penalties disincentivize doing exactly that. One of the cardinal rules of debt management is using unexpected cash windfalls to pay off debts. If you are stuck in a loan with prepayment penalties you lose the ability to do this, and any financial flexibility that would come with it.
Any debts which accumulate interest should be paid off as quickly as possible, so finding a lender that does not have prepayment penalties is extremely valuable. Make sure you read the fine print and investigate whether any lender that you consider charges prepayment penalties.